iShares MSCI Japan SRI ETF GBP (LSE:SUJA) - ETF price


ETF Report

iShares MSCI Japan SRI UCITS ETF (GBP) SUJA

AnalystReport

PortfolioConstruction

The MSCI Japan SRI Index is carved out from the MSCI Pacific SRI Index. The regional parent index selects the top quartile of companies ranked on MSCI’s firm level combined ESG scores per sector. A hard values-based screen is also applied. These exclusions span companies involved in nuclear power, tobacco, alcohol, gambling, military weapons, civilian firearms, GMOs, and adult entertainment. Also excluded are companies that don’t adhere to international norms and principles such as the UN Global Compact and International Labour Organisation Core Conventions. All remaining Japanese stocks from the parent index are then free-float-adjusted and market-cap-weighted. The index is reviewed on an annual basis in May to coincide with the semiannual review of the parent index as well as on a quarterly basis coinciding with the regular index reviews of the parent indexes. Constituent changes are implemented at the end of February, August, and November. It removes names that do not meet ESG eligibility criteria, and new ones are added to those sectors with market cap coverage of less than 22.5%. In order to minimise turnover, a 10% buffer is applied on the target coverage of 25%. At the time of writing, the index holds 66 of the 322 constituents of the MSCI Japan Index. The two largest holdings, Sony and Honda, have index weightings above 5%. By way of comparison, no stock within the MSCI Japan Index currently exceeds 2%.

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Fees

The fund has an ongoing charge of 0.30%, making it much cheaper than active peers. However, there are cheaper passive options--both ESG-screened and -unscreened--available. In 2018 the fund lagged its index by an amount approximating its ongoing charge, indicating tight tracking. Other potential costs for the investor include bid-ask spreads and brokerage fees when buy and sell orders are placed for the ETF.

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FundConstruction

The fund uses full physical replication to track the performance of the MSCI Japan SRI Index. It achieves this by holding all index constituents in their prescribed weightings. The fund distributes dividends semiannually in February and August. The fund does not engage in securities lending. IShares holds a dominant position in the European ETF marketplace by virtue of its comprehensive offering. The fund management process is robust. We value the wealth of experience of the people behind it and the extensive internal network supporting the operation. Having said that, we take the view that the vast economies of scale generated by the BlackRock group could be better shared with investors in the form of lower ongoing charges.

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Suitability

IShares MSCI Japan SRI ETF employs a strategy that results in sizable persistent sector and size bets versus the Japanese large-cap equity Morningstar Category, making it an imperfect tool for gaining exposure to Japanese large-cap equities. For this reason, we have awarded the fund a Morningstar Analyst Rating of Neutral.

The MSCI Japan SRI Index provides approximate exposure to the top quartile of Japanese companies ranked on environmental, social, and governance criteria. In addition to picking the most compliant stocks by sector it also applies several values-based hard screens, covering issues like controversial weapons and tobacco. The lack of an issuer cap means that the index has significant single-stock exposure. For example, in September 2018 Sony alone held almost 9% of index weighting.

Importantly it includes all Japanese stocks in the Pacific SRI parent index (rather than the most ESG-compliant holdings in the MSCI Japan Index). This feature of the index means that it suffers from persistent sector biases versus both the MSCI Japan Index and its average category peer (for example, a large financials underweighting). The selection process has also resulted in a pronounced large-cap bias relative to peers.

The fund has an ongoing charge of 0.30%, making it cheaper than active peers in the Japanese large-cap equity category. However, significantly cheaper passive options--both ESG-screened and -unscreened--are available.

Performance has been underwhelming. The fund has lagged similarly priced MSCI Japan trackers but beaten the category average on a risk-adjusted basis since inception in March 2017.

The seasoned passive management team at iShares is staffed with high-calibre personnel who can leverage market-leading technology when managing funds.

While this fund is not without merits, an uncompetitive fee and a fund strategy that  creates persistent single-stock, size, and sector bets versus peers mean that it is an imperfect core building block for investors seeking large-cap Japanese equity exposure.

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Fundamental View

Much ink has been spilt on the topic of whether ESG investors must necessarily sacrifice performance, or indeed whether ESG screening can actually boost returns. Our own studies on the subject have concluded that ESG funds and indexes perform on par with comparable conventional funds and indexes; companies with higher ESG scores and ratings can outperform comparable firms in both accounting terms and stock market terms; and a focus on company-level ESG factors rather than exclusionary screening can lead to better risk-adjusted performance at the portfolio level.

Looking forward, the main outperformance thesis rests on ESG’s implicit "quality" play. This suggests that well-governed and fit-for-the-future firms are well-insulated from the growing reputational and regulatory risks associated with unsustainable practises.

In practise, results in Japan have been mixed. While the MSCI Japan SRI Index managed to avoid direct exposure to some high-profile scandals at Nissan and Toshiba, in other cases it has actually overweighted troubled companies. In the case of Kobe Steel--its governance crisis wiped out 40% of company value overnight--the index had almost quadruple the exposure of the standard MSCI Japan Index.

Even more alarming is the case of high-end carbon fibre specialist Toray Industries, which suffered a data-quality/governance scandal in November 2017. As of writing, the fund is still in the MSCI Japan Index, having lost over 35% of its value.

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Alternatives

There are several other passive eurozone ESG-flavoured ETFs from which to choose. These include UBS MSCI Japan SRI ETF, which tracks a capped version of the same index for and has an ongoing charge of 0.40%.

Stricter on ESG selection is Xtrackers ESG MSCI Japan ETF, which targets companies demonstrating both a robust ESG profile and a positive trend in improving that profile, while using additional hard tobacco and carbon-based exclusions from the parent index. It selects the highest-scoring half of the parent index on ESG criteria. With an ongoing charge of 0.20%, it is also a very low-cost option.

IShares MSCI Japan ESG Screened UCITS ETF offers a lighter ESG screen, also at a lower cost. Launched in October 2018, the fund screens out seven sectors including controversial weapons, nuclear weapons, thermal coal, civilian firearms, tobacco, and oil sands, while excluding all companies violating the UN Global Compact principles. At the time of writing, it has 13 fewer holdings than the MSCI Japan Index and has an ongoing charge of 0.20%.

Finally, IndexIQ Factors Sustainable Japan Equity ETF reweights a universe of high-ranking ESG stocks on quality, value, and low-volatility metrics. The fund levies a fee of 0.30%.

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